Trade Idea – $QCOM: Placing Chips Post Dip

by Dan December 14, 2015 3:32 pm • Commentary

Qualcomm, both the company and its stock have had a bad year (QCOM). The company has been hit with threats from both China and European regulators regarding their selling practices in those regions, while they have had some difficulty collecting licensing fees in countries like China for their mobile chips.  Its stock is down 38% on the year, reflecting these issues. That’s in a year where the Philadelphia Semiconductor Index (SOX) is down only 5% (likely mostly due to QCOM’s poor performance, with the backdrop of $100 billion worth of merger activity in the sector since the spring.

The stock today is making new 52 week lows, and has now matched its 5 year low:

QCOM 5yr chart from Bloomberg
QCOM 5yr chart from Bloomberg

Taking a longer term view of QCOM, since the tech bubble inflated and burst, QCOM was one of the first large cap dotcom darling tech stocks to re-test those lofty highs:

QCOM 16 year chart from Bloomberg
QCOM 16 year chart from Bloomberg

When QCOM was rejected at $80 last year it was kind of significant as many saw it as a matched high from the period for all intents and purposes as the stock  only spent FIVE trading days above $80 (albeit that was some five days, going to $100 and quickly reversing) in late 1999/early 2000. The stock then declined 75% by late June.  To put that initial move in context, the stock was $20 in mid September 1999, $100 in early January 2000, and then back to $20 in October of 2001:

QCOM Sept 1999 to Jan 2000 from Bloomberg
QCOM Sept 1999 to Jan 2000 from Bloomberg

That chart of the last three months of 1999 and first few weeks of 2000 shows just how nuts things were back then. There’s lots of talk about tech bubbles here and there now, but always remember, we are NO WAY near that insanity.

Putting the stock’s current $70 billion market cap in context (about the level at its highs in 2000, the stock split 2 for 1 in 2004), in fiscal year 1999 the company had about $4 billion in sales and $1.24 earnings.  In their fiscal year just ended (2015), QCOM had $25.3 billion in sales and $4.66 in earnings. The company now pays a dividend that yields 4.15% and in the midst of a $10 billion share buyback (spurred by activist investors earlier in the year).

So 2015 was a bad year for both the company and the stock.  As stated above, they had issues with regulators but they were also designed out of Samsung’s high-end smartphone, they saw increasing competition from the likes of Intel (INTC), a maturing smartphone market etc etc… But the stock is really cheap, with a killer balance sheet:

Market cap: $70 Billion

Cash: $31 Billion

Debt: $11 Billion

Enterprise Value: $50 Billion

So on a P/E basis QCOM is at 11x expected 2016 earnings, 2x Ev/Sales

INTC is in the process of buying Altera (ALTR) for $17 billion in cash, dramatically depleting their cash reserves and increasing their leverage ratio massively.

So on a P/E basis INTC is at 14.5x expected 2016 earnings, 2.7x Ev/Sales

MY TAKE:  Something has to give here. QCOM’s earnings, while down 20% from its peak in 2014, with sales down 11% is not falling apart.  I have argued in the past that the combination of INTC and QCOM should be a match made in heaven as INTC’s core competency is PCs and Servers, and QCOM’s in mobile (smartphones & tablets). One has fabs, the other doesn’t. The companies are both in California and could cut hundreds of millions in costs in an instant with little overlap in product portfolios and lots of cross selling possibilities.  The ALTR deal is a bit of a joke for the price, paying about 10x sales, for $1.8 billion in sales, about half focused on wireless.  It’s been my view for some time that INTC should drop the ALTR deal and buy QCOM.  But I suspect that with weeks away to the ALTR closing that’s not going to happen.

But perhaps in the wake of the $67 billion debt fueled deal to bring DELL public again and merge it with EMC and parts of VMW, maybe a deal to take the QCOM private would make sense given the lack of value being placed in public markets.

Our Trade: Playing for take-outs is a dicey investment strategy at best. I lay out the potential given the environment, involvement of activists and potential for one last blockbuster deal in the semi space before this bull run is said and done. But the cheapness of the stock and long period of miss-execution is the driving force for a contrarian bullish trade.

The next identifiable catalyst will be fiscal Q1 results on Jan 27th.  I want to look to finance the purchase of slightly out of the money calls in Feb by selling shorter dated out of the money calls that expire at year end.  

*Trade: QCOM ($46.66) Buy Dec 31st quarterly / Feb 50 call calendar for 1.30

-Sell to open 1 Dec 31st 50 call at 40 cents

-Buy to open 1 Feb 50 call for 1.70

Break-Even on Dec 31st Expiration:

-Max profit at $50, max risk of $1.30 with a sharp move above $50 or below current levels.

Rationale: once the Fed is out of the way, trading should slow down a tad and equity vol should settle a great deal into holiday shortened trading weeks. I want to look to off set some decay of the long Feb calls over the holiday period and then look to further spread the long Feb calls once Dec 31st expire.